A Guide to DeFi Yield Farming and How Does It Work?
This comprehension of crypto has undergone a radical upheaval in fewer than ten years. The term “decentralized finance” (DeFi) is becoming increasingly commonplace in cryptocurrency. It is possible to establish this ecosystem with a total value locked (TVL) rise in DeFi of $4 billion. Despite the unpredictability of cryptocurrency prices, DeFi yield farming has the potential to attract a wide audience.
Implications? The development of DeFi projects aims to eliminate the need for intermediaries in supporting and transforming traditional financial assets. Producing yields in farming has been made possible through decentralized marketplaces, insurance, loans, and borrowing.
In the following, you will find all of the information that you require concerning DeFi and yield farming. We look at the yield farming method, its uses, profits, and potential dangers.
What is DeFi Yield Farming?
The process of staking ERC-20 tokens and stablecoins to support the DeFi ecosystem is known as yield farming. The practice of yield farming, sometimes referred to as liquidity mining, is depositing and lending bitcoin to maintain a mining operation and earn earnings.
The concept of yield farming is comparable to that of staking, but the method used on the Ethereum blockchain is more advanced. To increase their earnings potential, yield farmers often move their digital assets from one loan market to another.
Yield farmers are required to invest their funds in a lending protocol, such as Compound or MakerDAO, to contribute to the liquidity of financing pools. There are benefits for both the borrowers and the lenders. One cUSDT token is given to a yield farmer who spends 1,000 USDT in Compound. This investment earns the farmer the reward. To lower the transaction costs, these tokens can be pumped into an AMM liquidity pool that accepts cUSDT. Farmers who produce Yield can take advantage of compound and liquidity pool incentives.
How to Start DeFi Yield Farming?
The DeFi protocols COMP and Aave were largely responsible for the huge boost in crop yields seen in the early summer of 2020. After the release of the COMP governance token, the number of AMM yield farming participants (including Balancer, Kyber Network, Tendies, and SushiSwap), as well as their popularity, increased significantly. Very quickly, yield farming emerged as one of the most widely supported concepts for DeFi. Compared to ETH and DAI, the acceptance of USDT on AMM platforms is significantly higher.
The manufacturing of agricultural goods is appealing for a variety of different reasons. The possibility of collecting interest on a loan is what contributes to the allure of yield farming. Regardless of their rank, yield farmers can stack their yields and receive several governance tokens.
How Does Yield Farming Work?
Only put some of your eggs in the farming yield basket. In many cases, it is made up of automated market makers (AMM), also known as liquidity providers (LP), who contribute money to the liquidity pool to keep the ecosystem functioning. The LP is entitled to compensation for facilitating transactions on the blockchain.
It is necessary to have both pools and providers of liquidity to keep the liquidation rate stable. In most cases, having more liquidity will entice extra resources.
Both simplicity and sophistication may be found in AMM. Yield farmers can borrow tokens, lend tokens to one another, and trade tokens with liquidity providers. Each transaction results in a fee being assessed against the liquidity providers. In addition to dividends, adopting the novel protocol will result in issuing extra tokens to encourage limited partners to contribute to the liquidity pool.
Ethereum is the underlying technology of DeFi. However, it also supports stablecoins. Stablecoins are denominated in US Dollars and belong to the DeFi family of cryptocurrencies, including DAI, USDT, and USDC. When you deposit USDT into the Compound, you will automatically be credited with cUSDT. The circulation of money can be done in any way that maximizes returns, and there are no restrictions on doing so; nonetheless, the procedure must be observed. Your current cUSDT balance will be affected by the protocol tokens.
It may be challenging to understand the procedures involved in yield farming because the practice is still in its infancy. Because yield farmers only seldom share their ideas, it can be challenging for new investors to get their businesses off the ground.
In comparison to cryptocurrency mining
The Proof-of-Work (PoW) algorithm is utilized in cryptocurrency mining, whereas yield farming uses the decentralized “money legos” environment that Ethereum provides. The protocol-based alternative to crypto mining, yield farming, does not require special authorization.
Mining for cryptocurrencies and yield farming use mining pools, but liquidity providers recognize important differences between the two practices.
Aside from the shared and decentralized peer-to-peer network, yield farming is analogous to borrowing and lending money, with governance tokens as the incentive. Crypto mining allows the new currency to be created since it involves hashing each transaction in a memory pool individually after mining a block.
Farmers and bitcoin miners both seek incentives by increasing their crop yields.
Liquidity vs. Yield
Put another way; liquidity mining is the process of purchasing governance rights and tokens with cash to amass many tokens. Liquidity mining, which combines the functions of mining and liquidity, is beneficial to the development of DeFi. Mining is acquiring new tokens produced by an algorithm by utilizing processing power to gain Proof-of-Work (PoW) tokens. An investor can contribute to the liquidity of a network by staking their coins in a liquidity pool such as Uniswap and obtaining a 0.3% swap upon the completion of each block.
Yield farming is a method that maximizes revenues across all DeFi platforms by making use of money and mining liquidity. Increases in earnings can be achieved by yield cultivators using various capital restructuring strategies. These include yield farming roots, raising liquidity for Synthetic ETH tokens (Synthetix), and borrowing Compound tokens at a 100% annual percentage rate to increase revenue.
However, while liquidity mining and Yield farming can lead to increased earnings by purchasing governance tokens, they are different.
Staking vs. Yield Farming
Token holders can generate passive income by contributing funds to a lending pool. Even though staking requires a validator to keep funds safe, the PoS protocol can pick a block generator randomly from among the validators.
Staking is spending additional bitcoin to boost the likelihood of the LP becoming a block validator. Payouts can take several days to process, depending on the maturity of the coin.
Farmers engage in the active trading of digital assets to acquire governance tokens or reduce transaction fees. In contrast to stakers, yield growers can deposit several currencies across all protocols. Growers of Yield can use the strategy of depositing ETH to Compound to mint cETH and then making another deposit of ETH to mint the third and fourth tokens.
Staking is a simpler method of agriculture than yield agriculture, which can result in some confusion over the chains. The yield farming method involves greater risk but offers a greater potential reward.
Best Platforms for DeFi Yield Farming
Farmers receive compensation for the liquidity they contribute to the platform. The interest rate and the fees might change depending on how the capital is invested. Which protocols encourage the development of a diverse range of yields?
Uniswap utilizes an AMM to effect the exchange of two untrusted currencies into a fund pool. The liquidity provider receives a 0.3% commission on each swap.
2. Compound Finance
Customers who borrow and lend cryptocurrency assets can receive COMP tokens as a reward. This is one of the most fundamental and conventional approaches that can be taken. The COMP platform is available to anyone who has an ETH wallet. Find out what the expected value of the token will be while also spreading enough liquidity to make the most of the incentives.
Aave Lenders who deposit funds will not only accrue interest but also receive tokens for their participation.
Balancer contributes monies to the pool using procedures analogous to Uniswap’s. LP can use custom fund assignments to get around Uniswap’s fixed money allocation.
Curve performs in a manner analogous to that of Uniswap; however, it enables swaps with larger values and lower slippage rates. Curve tokens can be staked on Synthetix to earn sETH, and the sETH can then be transferred to another staker.
Since their inception, Closing DeFI and Yield Farming have caused widespread uproar across the internet. The future is uncertain, despite having one million active users. Will introducing new apps with added value revolutionize yield farming and DeFi.